China’s economy is slowing down. Both official statistics and people’s daily experience appear to tell the same story. Disappointing retail sales figures for November spooked investors, deepening anxiety about the economy.
However, closer scrutiny reveals that the structure of Chinese output is actually improving, with consumption growing as a share of gross domestic product, while investment and exports fall. The trends show that China is on the right path, rebalancing its economy away from high-speed growth to high-quality development.
Recent research from the OECD also suggests that knowledge-intensive service sectors are growing faster than labour-intensive ones. Investment in science, technology and innovation has grown steadily, with China overtaking Japan and the EU in 2014 to become the world’s second-largest spender on research and development.
The poor retail sales figures can partly be attributed to the effects of technological progress. The new digital economy is substantially reshaping traditional notions of product and service. Intermediate products and services that were once indispensable are now cut off from the value chain, and end users no longer need to pay for the considerable cost of those mediating links.
China is at the forefront of the so-called sharing economy and digital transformation more broadly, leading the way in the development of Big Data and artificial intelligence. It is a pioneer in technologies that allow customers’ needs to be identified more precisely and satisfied more quickly, without them necessarily having to pay any more.
There is a cultural aspect to this, too. A do-it-yourself ethos and an emphasis on self-sufficiency run deep in the Chinese national character. This is one reason why the sharing economy, peer-to-peer models of market exchange and ecommerce platforms have already been so successful in China, and why they are set to go from strength to strength in the future. It is clear that Chinese consumers will continue to play the roles of producers and service providers themselves quite happily.
While slowing retail growth should not be a big concern, the real issue for policymakers in Beijing is to maintain the momentum of consumption and of the economy as a whole.
Classical economic theory stresses the importance of credit creation and money supply. Given that China’s real economy currently relies heavily for financing on commercial bank lending, credit expansion and the injection of liquidity ought to benefit both the retail sector and the wider economy.
Hence proposals from policymakers, including a stimulus package of active fiscal policy and neutral-to-loose monetary policy. However, it is important to see the bigger picture. Substantial improvements to China’s financing structure are essential.
First, reducing the overdependence on commercial bank lending is central. Commercial banking was a product of the industrial revolution and was the major engine of financing throughout the industrial age. But it is clearly less relevant in the digital era, which is characterised by increasing “disintermediation”, in which investors and borrowers bypass banks to tap capital markets directly.
In China, bank loans account for a substantial proportion of corporate funding. Most bank liabilities are individual savings and corporate deposits. But tech-oriented start-ups tend to fund themselves using equity investment, meaning they are not a good match for commercial banks.
While commercial banks should continue to service basic financial needs, they must also seek to develop capabilities in trading, investment banking and digital banking. Equipping banks to offer comprehensive financial solutions should be a priority.
Furthermore, the recent decline in equity funding for Chinese corporates highlights the urgent need for a well-functioning capital market. Although China has set up several stock exchanges to optimise the funding mix, equity is still not a significant source of capital. Investors tend to focus almost entirely on the ups and downs of the indices. Fundamental issues such as the quality of listed companies, the need for a streamlined process for initial public offerings, effective information disclosure and a well-defined regulatory framework are neglected.
Reshaping the structure of corporate financing and reforming the banking system are essential if the rebalancing of the economy towards consumption is to be achieved without too much disruption.
The writer is a member of the China Finance 40 Forum